The government's submission to the Low Pay Commission argues for the main adult rate to hit £7 an hour by 2015. This is a significant move for a number of reasons.
First - and most importantly - if implemented, it would mean a real-terms pay rise for the lowest paid workers, who have seen their earnings decline relative to prices for the best part of a decade. Unemployment has not risen anywhere near as far as economists would have expected given the scale of the recession we faced in 2008-09, but the picture on wages has been dire.
Second, it underlines the political importance of living standards and the success Ed Miliband has had in placing this question at the centre of the national discourse. It is no surprise that the chancellor wants (at least some of) the increase to be felt in people's pay packets in the October before the general election. It is significant that some of the loudest voices advocating this move came from within his own party, particularly people like David Skelton and Robert Halfon who understand the scale of the challenge for Conservatives in breaking out of their current minority electoral conclaves.
Third, the public nature of this 'advice' to the Low Pay Commission from a very senior member of the government is novel and striking. The LPC is one of the few successful examples of a social partnership institution in this country (unlike most of our continental neighbours) and until now ministerial input into its decisions has happened only behind the scenes. How the independent commission responds to this lobbying will be fascinating to watch. At the very least it will lead to the unusual case of trade union negotiators praying in aid the views of a Conservative chancellor to bolster their argument to business about the merits of its pay claim.
Finally, given the salience of welfare spending to current political debate, it is worth a comment on the implications of this move for that debate. If the minimum wage rose to £7 an hour, the financial gain to the low paid would be real and meaningful, and we should a priori prefer an economy where people earn their way to a decent standard of living, rather than relying on the state. However, it is also true that some of the gain of a higher minimum wage will accrue to the state, in higher taxes (largely via national insurance contributions) and reduced benefit payments.
This speaks to a larger point. Part of the reason why the cost of benefits and tax credits have risen in recent years is that they have played an increasing role in topping up the incomes of working households. That means that trends in wages now have a very big impact on welfare expenditure - in addition to patterns of employment. We recently did some modeling to underscore this point.
We found that if average earnings were to fall by 1.5 per cent in real terms in 2013/14 - as they did in 2012/13, and as the OBR predicts for this year - it would cost the Treasury almost half a billion pounds (£497 million) more in tax credits and benefits than if earnings growth were to remain flat in real terms. More significantly, if earnings growth were to return to something approaching a 'normal' level this year, such as a real-terms rise of 2 per cent, then tax credit and benefit spending would be £1.1 billion lower than it will be if the forecasted real-terms fall of 1.5 per cent occurs.
This analysis also found that patterns of wage growth have an even larger effect on income tax and national insurance receipts. For example, annual revenue in 2013/14 would be £5.4 billion higher if real earnings growth were to remain flat than if earnings were again to fall in real terms by 1.5 per cent, as they did in 2012/13. If real wages were to rise by 2 per cent this year then the difference would be a staggering £12.5 billion.
This is almost equivalent to the annual amount raised by the chancellor from increasing VAT from 17.5 per cent to 20 per cent, and more than George Osborne says he wants to cut from the welfare budget in the next parliament. Yesterday's announcement was potentially great news for low-paid workers. It should also lead policymakers to make the connection between wages and benefit spending, given that both will be central to the political battleground in 2014 and beyond.
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